Profit fade — a gradual decline in expected gross profits over the course of a project — can be the bane of many contractors’ existences. This scourge may not only hurt your financial performance, but also may raise a red flag with sureties and lenders. To avoid profit fade, you’ll need to identify its causes, monitor work in progress and act quickly to address any issues you uncover.
Spot the causes
So just what can cause profit fade? Many things, and often a combination of them, including:
- Poor or overly optimistic estimating,
- Inaccurate job costing,
- Unbillable extra work or change orders,
- Unsatisfactory performance by subcontractors or suppliers,
- Lax project management or field supervision,
- Inadequate resources or training, and
- Adverse weather conditions or other unexpected jobsite challenges.
It’s normal to experience any one of these over the course of your business. However, if your jobs regularly suffer from profit fade, it’s time to take steps to mitigate the problem.
Follow these tips
Here are several tips for preventing profit fade:
Examine your systems and procedures. Evaluate your estimating and job costing systems and procedures to be sure they’re accurate and complete. Consider using more conservative assumptions in your estimates. Build in contingent costs to provide a cushion against unanticipated delays and expenses.
Review your past jobs. Analyze past jobs to look for patterns and trends. Is there a correlation between profit fade and certain factors, such as job type, location, contract size or customer? Is profit fade more likely to occur on jobs involving certain estimators, project managers or other personnel? Talk to employees involved with those jobs to identify any factors that caused actual costs to exceed estimated costs. Use this information to improve your estimates and management practices on future jobs.
Scrutinize your contracts. An ambiguous or poorly drafted contract can quickly lead to unanticipated costs — particularly if you and your client have different expectations regarding the work involved. Be sure your contracts clearly define the nature and scope of the work you’re expected to perform and provide straightforward change-order procedures to ensure that you’re compensated for extra work.
Create budgets. It’s impossible to determine whether a job is veering off course unless you’ve mapped out your route in advance. For each job, develop a thorough, realistic budget tied to the original cost estimate and establish procedures for reporting actual and expected completion costs as the job progresses.
Monitor work in progress. You must monitor a job’s progress and investigate discrepancies between budgeted and actual performance. Regular work-in-progress reports can help you track contract prices, amounts billed, costs incurred to date, projected final costs and estimated gross profits. Continually monitoring this information allows you to spot problems early and resolve them before they do irreparable harm.
In the construction business, no one likes surprises. You don’t want to discover after completing a job that it wasn’t nearly as profitable as you’d anticipated. By taking steps to mitigate profit fade, you can avoid such surprises, fix problems before it’s too late and ensure that your jobs perform at a high level from beginning to end. Frazer, LLP is here as a resource to double-check your numbers and suggest helpful refinements. Please contact us for help.
Brian Tunnelle, CPA, CGMA, MBA, CCIFP